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The Money Management Newsletter: Investing in Mutual Funds
Guaranteed Mutual Funds... Are they better?
Beyond the sales pitch...

By Rob Whipp - August 1999

Over the past year many mutual fund companies have been promoting their new segregated (seg) fund products, which they offer in association with various life insurance companies, focusing on such benefits as capital guarantees, death benefit guarantees, reset privileges and creditor protection On the other hand proponents of traditional mutual funds have noted that these aforementioned privileges come at a higher cost to the consumer and may never be realized. Putting these obvious comparisons aside, an investor also has to look at the taxation differences between the two types of investments because taxation is an ongoing issue that affects every investor and as noted below taxation differences apply not only between a given company's mutual funds and their seg fund counterparts but there are also differences among companies in how they report liabilities with respect to their seg funds

All references in this article are for investments OUTSIDE of RRSPs or RRIFs. The two taxation areas to compare will be distributions (investment returns passed through to the investor by the fund managers) and dispositions (when the investor sells or switches out of an investment). Let's look at distributions first. A mutual fund may distribute monthly, quarterly, semi-annually or annually any gains made by the fund manager and investors either receive a cheque for these or have them automatically reinvested into more units. If the distribution is reinvested investors will normally receive a transaction confirmation for the additional units noting the dollar amount received, number of units and the price at which the units were reinvested. The unit price of the fund normally falls as well so that the fund value is the same after the distribution with the additional units as it was before with less units. (ignoring any market increase or decrease). No matter when the individual holder invested in the fund if he/she holds units at the time of the distribution, the number of additional units he receives is based strictly on the number of prior units he/she was holding. The amount of the distribution is of course taxable. The investor has to keep track of how the reinvested units affect the investment's adjusted cost base so that capital gains or losses are properly reported by the investor when the investment is sold. A T-3 will be received for the amount of the distributions.

The seg fund version of the investment may receive different treatment. A mutual fund seg fund does not have distributions per se. They have allocations and these allocations are only made on December 31 of each year no matter how frequently the underlying mutual fund has distributions. Investors do not receive separate confirmation of any allocations but they are reported on the year end statement they receive. (some companies are working on a form of confirmation) With these allocations investors do not receive any additional units however the fund company makes an internal adjustment to the investors adjusted cost base and keeps track of it. Also since no additional units are received the allocation does not cause the unit price of the investment to drop. Some companies "time weight" the allocation so that the taxable amount allocated to an investor is based both on the number of units held and the length of time the investor has held the investment. A T-3 will be received for the amount of the allocation.

What's good and bad about the two? Many investors are annoyed if they receive a large taxable distribution from a mutual fund shortly after purchasing it, so if the segregated (seg) version of the same fund time weights the amount of its allocations it may be more attractive. The problem is not all seg funds time weight so you will need to do some investigation. The lack of reporting on the amount of seg fund allocations could be a problem if you don't read your end of year statement closely. Receiving a T-3 for a large amount in February that you are not prepared for could be a major shock. With the mutual fund the investor has to keep track of his adjusted cost base but with the seg fund the company should do it for you which will make record keeping easier (as long as you have faith in their record keeping).

Dispositions are also treated differently. With a mutual fund as mentioned above the investor has to keep track of an investment's adjusted cost base and it is the investor's responsibility to properly calculate any capital gains or losses on disposition and report them on a schedule 3 on the tax return. No T-3 slips are received from the mutual fund company for dispositions. Any sales charges the investor paid to purchase the fund or paid on redemption. It is also the investors responsibility to keep track of and report on their tax return any sales charges or redemption fees paid for any mutual funds sold if they wish to reduce any capital gains or increase any capital losses.

With a seg fund since the company keeps track of the adjusted cost base they will report on a T-3 the amount of capital gains or losses particular to the disposition of the particular investment. Any sales charges paid either at purchase or redemption are not included in the disposition gain or loss but are reported separately as a capital loss on the T-3.

What's good and bad? Certainly the seg fund reporting of disposition gains and losses on the T-3 makes record keeping simpler as long as you agree with the seg fund's figures and how they arrived at your adjusted cost base.

The seg fund will not only report gains or losses when an investment is sold but also when an investor switches between investments in the same fund family. Although mutual fund investors are supposed to report their gains when they switch funds I believe that many don't, either deliberately or through sheer ignorance, so the seg fund reporting will keep them "honest". The above comparisons are by no means comprehensive but I hope they provide some insights.

As complicated as it might be your best bet is to become completely familiar with the information folder to ensure you understand what you are getting with your seg fund investment.